"Ijarah" is a term of Islamic fiqh. Lexically, it means 'to give something on rent' or 'to lease'. In the Islamic jurisprudence, the term 'Ijarah' is used for two different situations.

In the first place, it means 'to employ the services of a person on wages given to him as a consideration for his hired services." The employer is called 'musta'jir' while the employee is called 'ajir'.

The second type of Ijarah relates to the usufructs of assets and properties, and not to the services of human beings. 'Ijarah' in this sense means 'to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.' In this case, the term 'Ijarah' is analogous to the English term 'leasing'. Here the lessor is called 'Mu'jir', the lessee is called 'musta'jir' and the rent payable to the lessor is called 'ujrah'.

We are only concerned about the second type of ijarah because it is used for financing in the Islamic financing system.

Lease as a mode of financing

Like murabahah, lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed period against an agreed consideration. However, certain financial institutions have adopted leasing as a mode of financing instead of long term lending on the basis of interest. This kind of lease is generally known as the 'financial lease' as distinguished from the 'operating lease' and many basic features of actual leasing transaction have been dispensed with therein.

When interest-free financial institutions were established in the near past, they found that leasing is a recognized mode of finance throughout the world. On the other hand, they realized that leasing is a lawful transaction according to Shari'ah and it can be used as an interest-free mode of financing. Therefore, leasing has been adopted by the Islamic financial institutions, but very few of them paid attention to the fact that the 'financial lease' has a number of characteristics more similar to interest than to the actual lease transaction. That is why they started using the same model agreements of leasing as were in vogue among the conventional financial institutions without any modification, while a number of their provisions were not in conformity with Shari'ah.

As mentioned earlier, leasing is not a mode of financing in its origin. However, the transaction may be used for financing, subject to certain conditions. It is not sufficient for this purpose to substitute the name of 'interest' by the name of 'rent' and replace the name of 'mortgage' by the name of 'leased asset'. There must be a substantial difference between leasing and an interest-bearing loan. That will be possible only by following all the Islamic rules of leasing.

To be more specific, some basic differences between the contemporary financial leasing and the actual leasing allowed by the Shari'ah are indicated below.

The commencement of lease:

Unlike the contract of sale, the agreement of Ijarah can be effected for a future date. Thus, while a forward sale is not allowed in Shari'ah, an 'Ijarah' for a future date is allowed, on the condition that the rent will be payable only after the leased asset is delivered to the lessee. In most cases of the 'financial lease' the lessor i.e. the financial institution purchases the asset through the lessee himself. The lessee purchases the asset on behalf of the lessor who pays its price to the supplier, either directly or through the lessee. In some lease agreements, the lease commences on the very day on which the price is paid by the lessor, irrespective of whether the lessee has effected payment to the supplier and taken delivery of the asset or not. It may mean that lessee's liability for the rent starts before the lessee takes delivery of the asset. This is not allowed in Shari'ah, because it amounts to charging rent on the money given to the customer which is nothing but interest, pure and simple.

The correct way, according to Shari'ah, is that the rent be charged after the lessee has taken delivery of the asset, and not from the day the price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.

The various benefits of Ijarah are:

a. It is easier to lease than to borrow for short term needs since it mostly does not require credit evaluation.

b. Gives more freedom of changing equipment as technology advances.

c. Easier to get finance through leasing for companies with lower credit standing. These kinds of companies may not be able to borrow from banks or public and if they do, have to pay a high rate of interest.

d. In many cases leasing can be advantageous from taxing point of view. These advantages may accrue to lessee and sometimes to lessor since equipment leased remains in the ownership of the lessor and hence can be counted, from tax point of view an investment.

e. In many countries leasing is an off sheet finance. The most important Shariah aspect of leasing are: